Perspective on the Correction

Friday’s economic data fit perfectly with the current “glass half empty” approach that has been the excuse for the current market correction. Employment numbers were worse than projected and factory data suggested economic momentum might be ephemeral.

Technical warning signs abound. The major indices all closed near the lows of the week on above average volume. And copper (JJC), which we discussed in July as more than just a commodity play but a leading indicator of economic growth, is leading the NASDAQ to the downside and declining on volume beneath its 50 MA after putting in a topping formation the last two months. A reversal in copper is critical, in our view, if the market uptrend is to resume.

The dailies of the major indices are indeterminate for the immediate future, which is why we suggested exiting recent longs in which you might not have sufficient cushion to endure an ongoing correction.

Thursday’s downside priced in Friday’s ugly economic statistics but the markets still declined Friday, albeit on slowing volume. While that could be a sign that selling is exhausting itself here, technically after a three day decline we had every right to expect some type of reversal in Friday’s performance. We might still bounce early this week but it is not a given.

When all is said and done, however, we continue to operate on the assumption that this pullback is buyable. We have four reasons.

First, economic recovery is first and foremost about earnings, not employment statistics and consumer sentiment, and we expect another excellent string of quarterly reports. Granted, last quarter was mostly driven by cost cuts and commodity savings for producers while sales growth was anemic. We expect cost cuts and commodity savings to continue to contribute to the bottom line while sales growth will show signs of acceleration.

Second, in spite of a bounce the last two weeks or so, the US Dollar Index (DXY) remains in a downtrend that has been in effect since the March bottom in stocks. Unless the dollar reverses to the upside we expect a weak dollar to continue to be supportive of stocks.

Third, gold remains secure in its break out. This is important because it supports our thesis of a weak dollar. But it does something more. It indicates the market, which began to sell off (as we predicted it might) on fears the Fed would begin to remove monetary accommodation, is ultimately confident that day of reckoning is still sufficiently far enough into the future to warrant further upside in equity prices.

And this leads into our final assumption: that the market rally will endure until the Fed ultimately begins to remove accommodation. We believe the economic statistics we have seen the last few weeks will be sufficient to convince Fed members, for all the bluster of some of the governors, that the time is simply not ripe to drain liquidity from the system. Indeed we believe that could be well into 2010.

When it does happen, combined with some anti-growth policy changes the Democrats are mulling, the market reaction could be brutally ugly. But that is for another time. For now focus on the correction as it continues to unfold and be prepared to secure excellent entry in leading stocks should we see signs of an impending reversal.